THE EXPERTS: No Bounce in CMBS This Spring

IF MAY IS ANY INDICATION, commercial-mortgage players should have plenty of time to hit the beach this summer, according to the Barron's/John B. Levy & Co. National Mortgage Survey.

Despite long-term fixed rates at less than 7%, and floating rates that in many cases are less than 4%, loan demand is tepid at best. New issues of commercial mortgage-backed securities are down 25% to 30% from last year and could run even slower if the pace of originations continues.

Economic uncertainties have originators striving to assure buyers of the quality of their deals. Richard Parkus, head of CMBS research at Deutsche Bank, rated more than 20 originators based on their annualized default rates since 1995. The statistics are based on almost 33,000 loans in 186 conduit CMBS transactions.

To perhaps no one's surprise, Wells Fargo garnered the No. 1 ranking. Remarkably, only two of the almost 1,450 loans they have securitized have become at least 60 days delinquent during the term. At the other end of the scale is Merrill Lynch, where 74 loans have defaulted.

Interestingly, though banks are thought by some to have a more stringent credit culture, Deutsche Bank's research doesn't necessarily support that idea. Originators such as Bear Stearns and Heller Financial, recently acquired by GE Capital Corp., are ranked No. 4 and No. 5, while banks such as Wachovia and PNC Financial Services Group are well down in the pack, at No. 17 and No. 18.

One surprising note is the performance of Nomura Securities. Thought by many to be something of a bad boy, it lands smack in the middle at No. 13, right between Morgan Stanley and Citigroup.

Big Offering

Securities buyers will have a new opportunity to buy into the Wells Fargo track record as Morgan Stanley brings to market a new CMBS transaction, titled TOP 7. Wells Fargo is the largest contributor of collateral to this $970 million pool, with other contributors including Bear Stearns, Principal Life and Morgan Stanley. About 86% of the securitization is rated triple-A by Moody's Investors Service, compared with the most recent previous conduit deal, led by Wachovia, where the triple-A tranches were only 78%.

Despite the Moody's seal of approval, some potential buyers view the pool with concern. Anchored retail makes up almost 36% of the assets, while multifamily loans, generally the most sought after, represent only 19%. Nevertheless, given the scarcity of new transactions and the prior success of the TOP series, underwriters are expected to have no trouble selling the entire deal.

Good and Bad News

Real estate long has been thought to be a lagging economic indicator, and delinquency data seems to support that. According to Trepp LLC, delinquency rates still were rising through much of the spring and only recently have shown a modest fall-off. But Pat Corcoran, head of CMBS research at J.P. Morgan, argues that delinquencies are like the level of water in a bathtub — what's more interesting is the default rate, or the amount of water coming into the bathtub.

Looking solely at the default rate or new delinquencies, J.P. Morgan's research shows a decline. The three-month annualized default rate, at 2.18% at the first of the year, has fallen to 0.78%, perhaps indicating that real estate is beginning to recover.

While the number of new-loan delinquencies may be declining, the average realized loss on a liquidated conduit loan is up sharply, according to Gail Lee, a director at Credit Suisse First Boston.

In a recent update, Lee notes that average loss severity, which was 32% of the principal amount 12 months ago, has risen sharply to 46%. Slightly more than 62% of the loans had losses of less than 50 cents on the dollar.

Surprisingly, 16 of the 92 liquidations had loss severities of more than 95%, far exceeding most analysts' expectations. Excluding retail and multifamily, the average loss was a strikingly high 67%.

Meanwhile, terrorism insurance still remains the single hottest issue in the market. Many lenders are seemingly willing to allow borrowers to defer the purchase of terrorism insurance on non-“skyline defining” buildings, but they are not waiving the requirement for terrorism insurance in the future.